Transparency in Financial Accounting: Are We Addressing Symptoms or Causes?
Basic conclusions that can be drawn from responses to this month's column are that it may or may not be useful to try to legislate accounting transparency. But such efforts address symptoms, not causes, of behaviors leading to purposely misleading financial reporting. As Scott Green puts it, "We cannot look at investor losses as the only benchmark to evaluate the costs of Sarbanes-Oxley. One must also consider the cost of capital if confidence in the markets does not return…Unfortunately, you cannot legislate morality..." This theme was picked up by Richard Eckel, who wrote, "... legislative and regulatory response treats the symptoms (means) rather than the disease (motivation). Transparency is only as successful as the least creative obscurantist." He recommends, among other things, prohibiting "by regulation public equity trading by corporate insiders of the insider's equity..."
Several respondents suggested the need for a careful approach to the issue of greater transparency. E. Smith asked, "Do investors care about immaterial smoothing [of earnings]? I do not believe so. It is when ... earnings management leads an investor to misunderstand the health of the company that makes this wrong." Ruth Sager suggests that the current reactions to misleading financial reporting could potentially go too far. As she says, "Fashion in any field is like that. It goes to a ridiculous extreme before becoming more practical. Legislation is therefore a problematic way to achieve the golden mean in normative behavior."
Edward Hare agrees, pointing out that "Corporate governance is a system that continues to fail us ... and joins the ranks of education, mutual funds, and healthcare ... Are ethics, integrity, and self-interest the common denominators to them all?"
Echoing his point of view, does our current approach to greater accounting transparency through legislation and regulation attack the symptoms and not the disease? If so, is this a reflection of the worth of attacking even symptoms in order to restore credibility to financial markets? And if not through legislation and regulation, how then do we address the disease rather than the symptoms? What do you think?